What Going Over The Fiscal Cliff Would Mean For Emerging Markets

Mark
Mobius is the Executive Chairman of Templeton Emerging
Markets Group. He currently directs analysts based in
Franklin Templeton's 18 emerging markets offices and
manages the portfolios. Dr. Mobius has spent more than 40
years working in global emerging markets and has received
numerous industry awards. He was named one of Bloomberg
Markets Magazine's "50 Most Influential People" in 2011 The
World Bank and Organization for Economic Cooperation and
Development appointed Dr. Mobius joint chairman of the
Global Corporate Governance Forum Investor Responsibility
Taskforce. He has authored several books on investing and
pens a blog, "Investment Adventures in Emerging Markets" at
mobius.blog@franklintempleton.com.

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Now that the U.S. presidential election is over and President
Barack Obama has been re-elected to serve a second four-year
term, we’re able to do what we always do after a major election
or regime change, and that’s examine the potential implications
of policy changes on our investments. As our team sees it, there
are two main factors for global investors to consider: the U.S.
economy’s future health, and President Obama’s foreign policy
stance toward key countries, particularly China.

Will the U.S. Fall off the Fiscal Cliff?

The biggest hot-button issue in the U.S. economy right now is
impending “fiscal cliff,” a sweeping combination of tax hikes and
government spending cuts which a then-deadlocked U.S. government
put in place in 2011 as a last-ditch effort to reduce the
nation’s US$1 trillion deficit. Unless the Republican-controlled
House of Representatives can reach agreement on an alternate plan
with the president and Democrat-controlled Senate, this fiscal
cliff – the fallout from what’s formally called the Budget
Control Act of 2011 – will go into effect in January 2013.

Some economists say that if the spending cuts and tax hikes
contained in the Act go into effect, it will lead to a U.S.
recession and the one-two punch of rising unemployment and
reduced consumer spending. The U.S.
Congressional Budget Office estimates a possible 4% hit to
the U.S. GDP (negative growth) between fiscal years 2012
-2013. I think such turn of events could create an economic
disaster, as a recession in the world’s largest economy would
undoubtedly impact the global economy, particularly Asia’s export
industries. If the U.S. goes “off the cliff” it could take
other countries down with it.

We can hope for the best, but we also have to plan for the worst.

The good news for emerging markets investors? Dependence on
exports to the U.S. has generally been declining in Asia and the
emerging countries over the past decade.The
absolute dollar figures for total exports have been rising, but
emerging market countries have been diversifying their export
base to include countries beyond the U.S. and Europe, the latter
of which, as we know, has been suffering from a debt crisis of
its own.

Today, China is the largest destination for exports from Japan,
Korea, the Philippines, Vietnam, Thailand, Malaysia, Singapore
and Indonesia. Nevertheless, it’s important to remember that the
U.S. is the world’s largest single economy, with a GDP of about
US$16 trillion, followed by China at US$8 trillion and Japan at
US$6 trillion. China’s economy is so large that its exports
to the U.S. represent only 5% of its GDP, but trade with the U.S.
is obviously important, as China is the United States’ second
largest trading partner. Most people probably think of China as
an exporter but it also imports many goods from the U.S.,
totaling approximately US$100 billion in
2011.1 The bottom line is that from an
investment standpoint, there could be negative implications to
Asian companies which export to the U.S. and Europe, but we
believe some of the stronger ones will likely survive.

Monetary Policy

Whatever the outcome on the fiscal policy side of the equation,
on the monetary policy side, I think the Federal Reserve is
likely to continue its “QE” monetary expansion, with the
objective of preventing a severe slowdown in the American economy
and, most significantly, of reducing unemployment. This stance is
important for the entire world—particularly for stock
markets—since increased liquidity can generally lead to higher
stock prices. While it’s also likely to lead to higher inflation,
good companies should be able to adjust their prices accordingly.
The U.S. money expansion is forcing other countries to take
similar monetary policy actions in order to prevent the U.S.
dollar from becoming too weak against their own currencies, thus
ruining their exports businesses. We thus see rapid expansion of
money supply not only in the U.S. but in Europe, Japan, China and
other countries to be likely. We’ll be watching the implications
of this in the coming year.

Foreign Policy

On the foreign policy side, President Obama’s policies have been
oriented toward an idea of “leading from behind” with more
cooperation with allies and an open attitude toward dialogue with
perceived “foes.”

The president has said that power alone cannot protect the U.S.,
and that it’s necessary to rely on alliances. In his words,
“…power grows from its prudent use” and it is necessary to use
“humility” and “restraint.” He seems to be looking to see changes
in America’s global economic role in an era where partnerships
are more important and negotiation is more effective than threats
and exerting military power.

Overall, I think this attitude and policy stance will probably be
positive for investments in Asia, since confrontation with China
seems less likely and the offshore island disputes between Japan
and China are likely to be handled gingerly by the president,
despite the Japan-U.S. military alliance.

We still have a lot of unanswered questions, and I’m a realist
about the risks, particularly in regard to the United States’
ability to solve its debt issues in short order. However, I’m
still optimistic about the prospects for equity investments in
emerging markets and in Asia in the coming year, whether the U.S.
falls off the fiscal cliff or not.